Tough Sell: A Cryptocurrency Backed by Oil

Amid the current cryptocurrency craze and despite the backlash from Bitcoin’s collapse in value, a group led by Bart Chilton, a former CFTC commissioner, is set to launch an oil-backed cryptocurrency called OilCoin in March. Chilton, known for calling for greater regulation and surveillance of commodity futures markets, believes cryptocurrencies such as OilCoin will eventually thrive despite current rampant speculation in digital markets. “Digital is how we will transact business in the future, business that will consist of deals done on people’s phones,” Chilton told The Fuse in an interview.

Despite the backlash from bitcoin’s collapse in value, a group led by Bart Chilton, a former CFTC commissioner, is set to launch an oil-backed cryptocurrency called OilCoin in March.

The current moment is a questionable time to launch a new cryptocurrency. Beyond the current collapse, other vulnerabilities have emerged: Young markets mean that blockchains are highly vulnerable to being compromised. Researchers have found that trading virtual currencies can be easily manipulated by bots, and hackers have stolen over $1 billion worth of digital money. The entire Bitcoin boom might have been a spectacular bubble—although some investors are confident that once it is widely accepted as a digital currency, it will fully recover and reach new heights.

Cryptocurrencies are also at an inflection point for how these currencies are managed. “We’re at a time in history when digital currencies will need to accept rudimentary regulations that will help them become effective, efficient, safe, and secure going forward,” Chilton added.

The biggest hurdle to a computerized monetary system is how to guarantee that transactions on the network are legitimate. Chilton argues that three factors are necessary for a cryptocurrency to succeed and for the integrity and legitimacy of the market to be protected. First, the currency needs to be supported by assets with intrinsic value, such as oil or gold. Second, it must be regulated similar to a stock or security in order to protect investors and assure that the currency is not used for money laundering or criminal activities. Third, the currency should be included in commerce so that investors can use it to purchase goods and services.

The lack of regulation of Bitcoin and other cryptocurrencies has enticed investors, but this has made it a reckless bet for some. “Right now, it is just speculation in cryptocurrencies. I’m concerned people have FOMO—fear of missing out,” Chilton said. “I’m worried that people are investing recklessly and they may lose most or all of their money.”

In perhaps the best illustration of the current frenzy, one digital currency, Dogecoin, which began as a parody, achieved a market value of more than $2 billion but is expected to collapse.

Chilton, who first called for regulation of Bitcoin in 2012, believes OilCoin will avoid the pitfalls of other digital currencies by following the three factors mentioned above. For one, it will be backed by a hard asset—oil—and its worth will track the price of the commodity. Second, OilCoin will be registered with the Securities and Exchange Commission, and it plans to comply with U.S. laws and regulations to increase its appeal to institutional and retail investors globally. Third, over the long term, after it becomes an established cryptocurrency, users will be able to make commercial transactions with it.

As OilCoin hopes to begin soon with its “initial coin offering,” it will not be the first oil-backed cryptocurrency. Venezuela plans to launch its own next month—called the petro—in which each coin is backed by one barrel of Venezuelan crude (worth about $60). The government is planning to sell tokens to investors and pay its workers in the digital currency as it seeks to circumvent U.S. sanctions and take bold measures to deal with hyperinflation and the country’s deep recession. Workers in Venezuela being paid with virtual money will have to contend with both a volatile currency in the bolivar and a cryptocurrency which is based on a volatile commodity.

The problems with OilCoin

With the instability and skepticism surrounding other cryptocurrencies, the launch of OilCoin begs the question: If an investor wants exposure to the oil price, why not simply invest in an exchange-traded fund (ETF) that tracks WTI and Brent or buy futures or options? The point with OilCoin is to create an entire virtual network of users in everyday transactions. Digital tokens are particularly appealing to many in the developing world who do not have access to banks and credit. Users in emerging markets, however, will have to contend with problems Venezuelans will soon face—volatility in the home currency, the digital currency, and the price of oil. Furthermore, using virtual currency to buy things has been challenging and it is unclear whether it will eventually become common. Businesses have been hesitant to accept Bitcoin as a form of payment, in part because of its sharp fluctuations in value.

Using virtual currency to buy things has been challenging and it is unclear whether it will eventually become common.

Whether users of OilCoin are institutional investors or common citizens in emerging economies, the cryptocurrency will have to contend with all the hallmarks that persistently trouble oil markets—limited transparency and boom-and-bust cycles. The irony of Chilton—an aggressive regulator and an outspoken critic of negative effects of financialization—launching a fund that could be a dangerous investment for many is not lost on his critics. See below for how oil is more volatile than currencies and gold, and has at times fluctuated as sharply Bitcoin.

OilCoin may have more integrity than other cryptocurrencies, but it will come under scrutiny as it is part of increased speculation surrounding oil. “OilCoin is basically a mini oil contract and looks a lot like a commodity ETF,” one money manager told The Fuse. “I see the rationale, but it’s not easily accessible and execution will be difficult. Who will use it? Who will accept it? A whole new network has to be created.”

OilCoin may have more integrity than other cryptocurrencies, but it will come under scrutiny as it is part of increased speculation surrounding oil.

The oil market’s financialization gained hold in the early 2000s and particularly took off in the middle of this decade. The influx of money from pension funds, ETFs, commodity trading advisors, hedge funds, and other non-commercial actors has altered oil trading and at times disconnected prices from fundamentals. OPEC has seized on the importance of speculative money by meeting with investors and attempting to manipulate sentiment and jawbone prices higher.

OilCoin is a product of increased financialization, and its durability will rely in large part on the stability of the oil markets and its ability to keep any one actor from developing an outsized influence on its value—a tough task even if it is traded under a regulatory framework. Crude oil price movements are constantly in flux as market participants react to production numbers, demand trends, inventory levels, OPEC policy, and macroeconomic developments—all factors investors in OilCoin will have to weigh on a daily basis. If the last few years are any guide, in both the digital currency world and in the global oil markets, many investors and users of OilCoin will set themselves up for failure.

Major oil producing countries, & wealthy individuals in certain petrostates, have injected billions of dollars into international soccer, and their reach is spreading in an attempt to promote their “soft power.”

Despite the backlash from Bitcoin’s collapse in value, a group led by a former CFTC commissioner is set to launch an oil-backed cryptocurrency called OilCoin. Here's why its investors will run into a number of risks.

Midstream bottlenecks in Canada and output declines in Latin American producers are reshaping the heavy crude market in the Western Hemisphere. Who are the winners and losers from the changes in fundamentals?

Oil prices are rising and US production is growing sharply, but the shale sector is still not turning a profit. Companies have had to raise about $500 billion in bond sales since 2010 and they have spent $280 billion more than they have generated in the past decade.

If more large upstream projects are not sanctioned in the next 12-24 months, oil prices will likely again approach $100 per barrel. Underinvestment and continued geopolitical risk suggest that oil markets are heading into another 'decade of disorder.'

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The Fuse is an energy news and analysis site supported by Securing America’s Future Energy. The views expressed here are those of individual contributors and do not necessarily represent the views of the organization.

Issues in Focus

Safety Standards for Crude-By-Rail Shipments

A series of accidents in North America in recent years have raised concerns regarding rail shipments of crude oil. Fatal accidents in Lynchburg, Virginia, Lac-Megantic, Quebec, Fayette County, West Virginia, and (most recently) Culbertson, Montana have prompted public outcry and regulatory scrutiny.

2014 saw an all-time record of 144 oil train incidents in the U.S.—up from just one in 2009—causing a total of more than $7 million in damage.

The spate of crude-by-rail accidents has emerged from the confluence of three factors. First is the massive increase in oil movements by rail, which has increased more than three-fold since 2010. Second is the inadequate safety features of DOT-111 cars, particularly those constructed prior to 2011, which account for roughly 70 percent of tank cars on U.S. railroads. Third is the high volatility of oil produced from the Bakken and other shale formations, which makes this crude more prone towards combustion.

Of these three, rail car safety standards is the factor over which regulators can exert the most control. After months of regulatory review, on May 1, 2015, the White House and the Department of Transportation unveiled the new safety standards. The announcement also coincided with new tank car standards in Canada—a critical move, since many crude by rail shipments cross the U.S.-Canadian border. In the words DOT, the new rule:

Since the rule was announced, Republicans in Congress sought to roll back the provision calling for an advanced breaking system, following concerns from the rail industry that such an upgrade would be unnecessary and could cost billions of dollars. The advanced braking systems are required to be in place by 2021.

Democrats in Congress have argued that the new rules are insufficient to mitigate the danger. Senator Maria Cantwell (D-WA) and Senator Tammy Baldwin (D-WI) both issued statements arguing that the rules were insufficient and the timelines for safety improvements were too long.

The current industry standard car, the CPC-1232, came into usage in October 2011. These cars have half inch thick shells (marginally thicker than the DOT-111 7/16 inch shells) and advanced valves that are more resilient in the event of an accident. However, these newer cars were involved in the derailments and explosions in Virginia and West Virginia within the past year, raising questions about the validity of replacing only the DOT-111s manufactured before 2011.

Before the rule was finalized, early reports indicated that the rule submitted to the White House by the Department of Transportation has proposed a two-stage phase-out of the current fleet of railcars, focusing first on the pre-2011 cars, then the current standard CPC-1232 cars. In the final rule, DOT mandated a more aggressive timeline for retrofitting the CPC-1232 cars, imposing a deadline of April 1, 2020 for non-jacketed cars.

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DataSpotlight

The recent oil production boom in the United States, while astounding, has created a misleading narrative that the United States is no longer dependent on oil imports. Reports of surging domestic production, calls for relaxation of the crude oil export ban, labels of “Saudi America,” and the recent collapse in oil prices have created a perception that the United States has more oil than it knows what to do with.

This view is misguided. While some forecasts project that the United States could become a self-sufficient oil producer within the next decade, this remains a distant prospect. According to the April 2015 Short Term Energy Outlook, total U.S. crude oil production averaged an estimated 9.3 million barrels per day in March, while total oil demand in the country is over 19 million barrels per day.

This graphic helps illustrate the regional variations in crude oil supply and demand. North America, Europe, and Asia all run significant production deficits, with the Middle East, Africa, Latin America, and Former Soviet Union are global engines of crude oil supply.